Poor productivity report could be good for investors

If investors need further proof that theories explaining why financial markets are busted, today's report on weak first quarter productivity could be useful.

I had always thought that the market would respond favorably to strong productivity growth. The reason is that profit growth should follow from productivity growth. And investors would bid up stocks figuring that companies' earnings acceleration would boost the present value of their future cash flows.

But either the market doesn't care about productivity and profit growth slowing down or it cares more about the Fed lowering interest rates. Here's where the productivity report comes in handy: It noted that output per hour of work eked up 1.7% in the first quarter compared to the 2.1% growth in last year's fourth quarter.

But most importantly for the Fed, the slowing economic growth hurt the growth in worker's pay -- as measured by unit labor costs -- which increased a mere 0.6% in Q1 compared to 6.2% in Q4 2006. If that unit labor cost growth stays under 1%, the Fed will assume that a slowing economy -- GDP grew a mere 1.3% in Q1 -- can take care of inflation -- and that could increase the odds of a rate cut.

With gasoline prices expected to hit as much as $4 a gallon this summer, those workers will be squeezed between their flat wages and rising cost of living. But investors want lower interest rates and the odds of getting them were boosted by today's report.

Peter Cohan is President of Peter S. Cohan & Associates, a management consulting and venture capital firm. He also teaches management at Babson College and edits The Cohan Letter.